Merrill Lynch, along with Pierce, Fenner & Smith, will bring to the market this week yet another in a string of CDOs that incorporate both funded and unfunded assets and liabilities. The $1.5 billion Bernoulli High Grade CDO I will be the first CDO managed by Babcock & Brown Securities, a subsidiary of Sydney, Australia-based investment firm Babcock & Brown.
The deal is backed by 76% cash assets - mostly prime and subprime RMBS - and 24% credit default swaps referencing double-A rated ABS CDO assets. While the CDO is technically static, the manager has the option to substitute collateral up until a default happens or the notes are paid in full.
Babcock plans to grow its CDO business, which is currently managed by a team of seven employees under Australia-based management. The capital markets group, which initially focused on Australian ABS transactions, was formed in 2002, according to Babcock and Fitch Ratings. While Babcock took a year to ramp up its first ABS CDO, its portfolio contains a higher percentage of cash assets than recent deals announced, such as Duke Funding Management's thirteenth CDO, Duke Funding X. The $1.2 billion deal is being brought to the market by UBS, and, in contrast to the Babcock deal, has a 70% bucket for synthetic subprime RMBS, a 14% bucket for cash subprime RMBS and 10% and 6.5% buckets for synthetic and cash prime RMBS, respectively. (ASR 03/20/06)
A number of managers continue to incorporate synthetics for a number of reasons, not the least of which is a faster ramp-up time and a wider selection of collateral. But despite the increasingly wide use of synthetics within ABS CDO structures, pure synthetic deals are not expected to overtake cash and hybrid deals as the most commonly issued structure, according to a Fitch. The level of risk inherent in mezzanine CDO transactions is expected to keep the sector grounded with all-cash and hybrid structures, while synthetic CDOs are more likely to dominate within high-grade transactions.
This type of synthetic CDO emerged last year, along with short/long CDOs, as a result of heightened liquidity within the synthetic ABS market. BlackRock Financial Management's Tourmaline CDO was the first marketed CDO considered to be a true "hybrid" deal to come to the U.S. market with both unfunded and funded assets and liabilities. Morgan Stanley brought the deal to market last year. Tourmaline was also the first hybrid CDO backed by mezzanine ABS, according to Morgan Stanley.
Sixty-five percent of the deal's assets were unfunded CDS, while 65% of the liabilities were in the form of an unfunded liquidity facility. The deal, which priced through tights of similar cashflow ABS CDO transactions, was so popular among investors that it was upsized to $750 million from $500 million. The Tourmaline deal priced on Sept. 2, closing shortly after a similar deal, Commodore IV. This deal was underwritten by Deutsche Bank and managed by Fischer Francis Trees & Watt.
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